I think the zloty/euro will drop by large in any case. It is because of the chronic deficit in current account. It rather matters when and how it will drop than whether. (Today the gap of daily zloty/euro candles, which was made earlier this month, was closed, but it is merely an adjustment within the moves of the short timespan).

The coming drop may be quick if:
1. One of the euro member states defaults, when the financial market will go funky so much that investors will short-sell not only the zloty but all the rising-nation currencies like what happened a couple of years ago.
2. Investors become so impatient for some reason that they increasingly change their position from long to short. Demotions by rating agencies may kick the move.

Without the above two exogenous factors, the zloty will drop much more slowly, during the mild process the equilibrium could change upwards as the Polish economy becomes growingly innovative. If the innovativeness is sufficient the equilibrium will shift higher than the current level and thus the zloty/euro will move upwards, in which the large drop that comes from the present equilibrium will turn out to have been ‘invisible’.

What we should not forget is that the actual equilibrium range of zloty/euro must obviously be much lower than the present level in view of current account while the desirable equilibrium range must be higher in view of debt management. There must be a gap between the two, where we observe an imbalance. The gap must be closed either by reducing the current account deficit or by make the public finance sounder.

On the premise that either of the above tow exogenous factors should be materialised, the extra factors to be considered are:
1. It is practically impossible in months to attain an economic structure that keeps the current account always in black.
2. The remaining alternative is to make the public finance sounder.
3. But, spending cuts will contract the effective demand to push the unemployment rate upwards.

The natural choice to attain a sounder public finance, therefore, is tax increase.

With tax increase, the extra factors to be considered are:
1. The group of households in a lower percentile of income distribution tend to show a higher propensity to consume than other groups of households in a higher percentile.
2. Though nominally proportional, a flat tax like VAT and flat income tax is, therefore, virtually regressive.
3. By a virtually regressive taxation, the income gap will widen and thus the income immobility will become rigid accordingly.
4. By a widened income distribution, the aggregate revenue through the taxation will reduce, because the authority in the real world with the real politics will have in any case to try to reduce the effective tax rate for the households of low percentiles of income distribution.

The sufficient level of revenue increase through increase in flat taxation, therefore, is politically IMPOSSIBLE in the real world.

The only remaining solution to increase the revenue is progressive taxation – in the real world.

Those who enjoy high incomes will certainly murmur against reinforcing progressive taxation, but all the Polish people should understand in the first place that this taxation is to be introduced not for pampering the poor of the society but for reshaping the public finance. It is the most important for the authority to see to it that the effective tax rate for the households of the lowest percentile of the income distribution will NOT be (much) reduced – but desirably very slightly increased if any politically possible – until the public finance is sufficiently sound. Without the authority’s commitment against further generosity for the poor, all the rich will unlikely to support this tax increase.

Flat taxation, if any, should be introduced to control the preference in each targeted market. For instance, a capital-gain tax should be increased to cool down the intensity of financial transactions when it is regarded excessive whereas VAT should be increased to contract the demand for goods and services when it is regarded as excessive whereas a bank levy should be introduced to discourage lending/investment activities when it is regarded as excessive. Flat taxation should thus not be the tool to directly attain a sounder public finance. In this regard, Poland should not follow the IMF which may highly probably direct Poles to increase rates of indirect taxation.

The above recommendation is apt not only for Poland but Japan, the economy where the public debt is as huge as 220% to GDP, of which about 95% (i.e. about 210% to GDP) is domestically financed via savings by the Japanese individuals mostly via their deposits at domestic banks, while the rates of VAT remain very low as its income taxation has been increasingly less progressive for the last three decades. (The highest rate of income tax used to be 70% in the early 1980s and 40% today, and according to the ruling coalition it is to be reduced much further as the IMF and rating agencies have growingly been pushing for much higher rates of VAT. The IMF, which is, I think, being either excessively Classical or excessively Hayekian these days, pushed for a VAT hike and radial spending cuts again the day before).

I have some thoughts in privatisation as well, but I will leave now.

11:47 am January 28, 2011

Anonymous wrote:

The reason Poland was the only one that avoided a recession has little to do with fiscal virtue. It's credit and other markets were simply less developed so that all the financial alchemy avoided it. Poland had two options - each one bad. Latch on to Russia or latch on to the EU. It initially chose the latter though now is vacillating. But guess what neither Russia nor the EU will be the driving force in the new world. The trouble for Poland is that it has nothing else geographically to latch on to. Thus, it has chosen to be a backwater of the EU which, in turn, is rapidly becoming a backwater itself. Without a growing population or growing private sector you're bound to go nowhere. What has gripped the EU and Poland is Latin American crony capitalism - a better option would be a US free market version or Chinese state capitalism. But any attempt to implement the former in Eastern Europe will be smothered by pettiness, corruption, bureaucracy and the existing Communist-based plutocracy. And, as for the latter, you have to have a dictatorial regime and plenty of national pride and belief in oneself to do what the Chinese are doing. In lieu of that there is only cynicism, self-hate and infighting in Eastern Europe. So Poland may grow a little bit here and there and maybe in 50 years its GDP will be 90% of Germany's. But by then both countries will likely be Muslim caliphates (but, of course, still on the periphery of the Muslim world).

12:01 pm January 28, 2011

Jan wrote:

@Anonymous

You wrote: "The reason Poland was the only one that avoided a recession has little to do with fiscal virtue. It’s credit and other markets were simply less developed so that all the financial alchemy avoided it..."

If you think of that primitive hypothesis, which, I know, is growingly popular amongst some groups of people, as true, I am leaving the following link to 'tentatively' counter that rubbish:

While Prof Balcerowicz is against using tax increase to attain a sounder public finance, saying that this approach failed in many countries, I would like to point out that we need to notice there are theoretically two ways of tax increase – indirect tax and direct tax – and that in the last couple of decades the trend was to expand indirect taxation such as VAT and not to re-examine income tax, which has increasingly been less progressive for the same period of time.http://www.tokfm.pl/Tokfm/1,103454,8219466,Jedyny_sluszny_kierunek__ciac_wydatki_i_zwiekszac.html
As I explained above, it is natural that the former approach failed to reshape the public finance of the country that took the policy.

The above doesn’t mean that the theory of Prof Balcerowicz is wrong. On the contrary, his must be correct by itself. Only is it that he is thinking of an extreme condition of the whole economic kinetics, because it is obvious that his approach stays within equilibrium analysis.

An economy forms a broader and more complicated dynamism. As Keynes assumes, this dynamism may come from the fact in the real world that an economy consists of two different kinds of private economic body – household and business enterprise. The hasty American interpretation of Hicks’ 'tentative' interpretation of the economics of Keynes utterly limits itself within equilibrium analysis so much that what Americans interpret as Keynesianism is only about the most extreme condition in the whole economic theory of Keynes. Most economists are thus basically neoclassical today in the point that they particular about equilibrium analysis. On the contrary, Prof Rostowski and the Tusk administration are presenting a more flexible approach. (It may mislead Americans if I call it the 'real Keynesianism'). In other words, established theories are not really wrong respectively by themselves but it is policies that can be wrong.

For instance, while the general equilibrium exists, the Efficient Market Hypothesis, an approach to a situation in which they say the equilibrium is attainable, is wrong. The theoretical background of Prof Balcerowicz’s reform is correct, but his reform largely hurt the long-term development, which we may ‘theoretically’ expect of the Polish economy, via devastated labour market and shifted financial risks from the government to households. While he appears to believe that the merits of his reform will outweigh the disadvantages, nobody can really assert it beforehand, because it depends on how in practice the whole entrepreneurship and innovation will change by the reform as time goes. His reform is thus a gamble. The merits of the first Balcerowicz reform in the 1990 actually outweighed the demerits, which were also huge, because the then Polish economy was in an extreme situation on public debt management – the then Poland was virtually broke.

In comparison, the reform implemented in the UK during the 1980s in the same context as its Polish counterpart let the demerits outweigh the merits. With the reform Prof Balcerowicz advocates this time, it is highly likely that Poland will follow what the UK has morphed into since the 1980s. It could be worse, because Poland is not as rich in net assets as Britain.

For instance, he seems to be pressing the government for a radical increase in efficiency and mobility of the labour market. It is indeed necessary to cut red tape so that start-up entrepreneurs will feel comfortable in doing businesses, and the government is actually struggling to do it. On the contrary, a 'general increase' in the liquidity of the labour market would only press down real wages, help big enterprises and at the same time discourage both start-up entrepreneurs and small- and medium-sized enterprises, the biggest chunk of the domestic output and employment, of the Polish economy.

I believe, therefore, that unless Prof Balcerowicz, widely known for his hot temper, loses his temper in the debate with Prof Rostowski the two heavyweight geniuses will reach a grand consensus immediately when Prof Balcerowicz has admitted that his prescription is not really right while his theory is very correct. It is, therefore, utterly fruitless to be arguing against each other without first recognising the difference between theory and policy, or a theoretical realm and a broader theoretical realm.

So, I fully support the debate proposed by Prof Rostowski, and it should include a written form to avoid turning it into a sensational media show that may highly probably eventually hurt the solidarity of the Polish nation.

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